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What happened today?

The short answer: Recession fears intensified, and the uncertainty swirling around tariffs remains a stiff headwind. I discuss the president’s Sunday comments below.

The Dow was down about 1,110 points at the low and finished down 890 points or 2.08%, the S&P 500 fell 2.69%, and the Nasdaq lost 4.00%

Last year’s winners are being ditched in favor of more conservative stocks and Treasuries.

MAGS, an ETF that invests in the Mag 7, lost 5.55%. It’s down nearly 15% since the beginning of the year. And the market cap-weighted Nasdaq and S&P 500 are feeling the heat.

Ticker RSP – the equal-weighted S&P 500 – lost 1.4% today. That’s a big move but roughly half the S&P 500’s decline.

Are we headed into a recession?

Monday’s selloff was precipitated by comments by the president.

In a Sunday morning interview on Fox News, President Trump declined to rule out a recession this year, noting, “I hate to predict things like that. There is a period of transition because what we’re doing is very big.”

We’re in a period of transition, and “You can’t really watch the stock market,” he said.
Trump 1.0 touted the stock market as a barometer of his administration.
Trump 2.0 isn’t worried about the stock market, at least publicly.
A Fed put?

Powell’s remark on Friday that “the economy has been growing at a solid pace” saved the day on Friday. It was a distant memory at the opening bell.

And the Fed is in no hurry to cut rates right now.

Back to the question: Are we headed into a recession?

Leading indicators such as weekly jobless claims and the ISM Services Index are not signaling a recession.

And the Fed doesn’t seem to be worried.

But sentiment is influencing investors, and some major banks are reflecting this.

JPMorgan Chase: “We see a material risk that the U.S. falls into recession this year owing to extreme U.S. policies.” They raised the risk of a recession this year to 40% from 30% per the WSJ.

Goldman Sachs: The probability of a recession this year is 20%, up from 15%. They cut their GDP forecast to 1.7% from 2.4% for 2025.

So, there’s no Trump put, and there doesn’t seem to be a Fed put.

In the short term, the market is oversold, and positive news could trigger a significant rebound.

For now, Trump doesn’t seem to be backing down on tariffs against Mexico and Canada, coupled with reciprocal tariffs on trading partners.

Bottom line—

When stocks are priced for perfection, and they were, disappointments create volatility.

The unfortunate reality is that if we enter a recession, a bear market becomes a strong possibility. Historical trends over the past 60 years suggest a bear market would be likely.

But a recession isn’t a foregone conclusion. I don’t think we are in a recession today, and continued economic growth, even if softer, should help cushion the downside, in my view.

Energy is cyclical, and oil lost ground, but energy stocks (XLE) rose today.

Plus, we’re not seeing a big selloff in junk bonds, what I call the economic canary in the coal mine. Ticker JNK fell 0.38% today, and the spread between Treasuries and junk bonds, which have ticked off the bottom, remains extremely narrow.

Corrections hit the market, on average, about once a year. That last 10% pullback occurred in the fall of 2023. We are overdue for a 10% pullback.

“The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

Powell couldn’t have been any more precise in his annual address at Jackson Hole.

There’s no wiggle room. The Fed will cut rates in September. Even if the Fed had fully intended to pull the trigger next month, Powell could have given the Fed a backdoor, maybe something like, “The time MAY SOON come for policy to adjust.”

Soon signals September. May gives them an out.

But the Fed isn’t one-data point dependent. A strong jobs report for August or a disappointing CPI just days before the Fed’s September meeting won’t discourage Fed officials.

The Fed made its intentions crystal clear. It’s ready to start easing up on the monetary brakes.

Inflation dominated the 1970s.

We’re well into a new decade, and inflation is once again a headline. It affects consumers; investors; everyone.

_{Data Source: St. Louis Federal Reserve March 2024}

Despite an unemployment rate that is stuck below 4%, despite strong job creation, despite a series of new stock market highs this year, consumer sentiment is in the dumps.

Why? Much has to do with high prices.

Inflation slowed more than most forecasters expected in 2023, and that’s great news, but progress has come to a grinding halt in the new year. Or worse, it’s re-accelerating.

Hope springs eternal

The Fed seemed intent on cutting rates this year, probably with the first cut in June. Fed officials were reasonably confident that progress would continue.

That’s why they lowered their guard and started talking about an easier monetary policy, which, in turn, helped juice stock prices.

The CPI is no longer in a disinflationary trend. Instead, price hikes have accelerated in 2024, as evidenced by the graphic above.

Just as Powell retired ‘transitory’ in late 2021, he’s no longer blaming the calendar for price re-acceleration this year.

However, he believes the Fed’s current stance is sufficient to return the economy to price stability–eventually. Let’s hope he’s right. We don’t need a repeat of the 1970s.

Fly in the ointment

But, what if a 5.25-5.50% fed funds rate isn’t all that restrictive? Job growth is strong, wages are rising, and government spending is off the charts.

Boosting aggregate demand in the economy via federal spending (and no tax hikes) is a great way to pump up GDP and job growth, but it also creates a tailwind for inflation.

In some respects, we’re all paying for higher spending via inflation, which acts like a hidden tax.

5 cut, 6 cut, 7 cut more.

Investors are chomping at the bit for the Fed to slash interest rates. Just a couple of weeks ago, March was to mark the first rate cut of the cycle, according to the CME’s FedWatch Tool.

And, going forward, the most likely path wasn’t simply a gradualist approach. The CME’s tool reflected (and still reflects) an aggressive series of rate cuts, up to seven 25 bp rate cuts at one point.

Yet, it’s not the first time investors have bet on a dovish Fed. It’s not the first time they jumped the gun on a Fed pivot or pause.

Honestly, I’m not sure why investors are so optimistic that the Fed will cave to their demands.

You’re thinking, “But hasn’t inflation slowed down?” It has. The core PCE Index is just below 3%. That would give the Fed cover to ease. The six-month annualized core PCE is just under 2%. That would also give the Fed cover to ease.

The core CPI has slowed but is near 4%, and progress has stalled. That’s far from the definition of price stability.

More importantly, GDP in the second half of 2023 expanded at an annual pace of over 4%. Nonfarm payrolls shocked just about everyone in January, rising by 335,000. Notably, the same thing happened last year when payrolls surged by about 500,000 in January.

It’s early, but the Atlanta Fed’s GDPNow Model puts Q1 growth at over 4%.

The consumer isn’t backing down, fiscal stimulus is in the pipeline, and companies are adding to payrolls. If the Fed is truly data-dependent, I’m unsure what would justify the five rate cuts that investors currently expect, let alone the six or seven projected in January.

Put another way, there are few signs the economy needs that much monetary stimulus.

For starters, the Fed has never embarked on an aggressive easing without a recession. Do investors expect the ever-elusive recession to materialize this year?

Well, based on the recent series of highs in the market, the answer seems to be a resounding no. Recessions and bear markets go hand in hand; at least, that’s what 60+ years of market history tells us. If investors were fretting over a recession today, we wouldn’t be seeing major indices near highs.

Final thoughts

Mostly upbeat data are not conducive to an aggressive cycle. Besides, the Fed has openly opined on the lessons of the 1960s and 1970s. Inflation has slowed down, but we’ve been on this merry-go-round before.

So, why are investors so optimistic the Fed will aggressively backpedal on rates this year?

Wall Street analysts were unusually pessimistic as the year began. Should we have been surprised? Probably not. Recession forecasts were all the rage as the year began.

A recent story in Bloomberg News points this out. In fact, since 2000, analysts had not forecast a down year until 2023.

Despite earlier concerns, the economy has held up well this year, and major indices such as the S&P 500 Index are heading into yearend in positive territory.

Notably, analysts failed to call down years, including 2000, 2001, 2002, 2008, 2018, and 2022.

Partly cloudy with a big chance of uncertainty

Predicting the economy and the stock market can be challenging. It is not a straightforward process. Models rely on many variables. Get some of the variables wrong and the forecast can go awry.

We can learn plenty of lessons from this year’s missteps by the pros. But let’s keep it simple.

Successful long-term investors avoid shortcuts. Market timers take shortcuts. Avoid shortcuts.

I’m confused. Powell and his cohorts at the Fed have expressed a steadfast commitment to getting inflation back to its 2% annual target.

Some recent remarks from Jay Powell include:

“Inflation remains well above our longer-run goal of 2 percent.”

“Inflation pressures continue to run high, and the process of getting inflation back down to 2 percent has a long way to go.”

“The labor market remains very tight.”

“We remain committed to bringing inflation back down to our 2 percent goal.”

The rhetoric is strong, but is the bark worse than the bite?

We just had another blowout jobs report, and core inflation is stuck above 5%.

But the Fed passed on hiking rates in June, and the Fed is penciling in just 2 more 25 bp rate hikes this year—that’s two of four meetings. That sounds like the very gradual pace of rate hikes we saw in the 2010s when inflation was hovering just below 2%.

Is the Fed really committed to getting inflation back down?

Last year, they talked a big game, and they followed through, much to the chagrin of investors. This year, I’m not so sure. Maybe it’s simply the fear that anything more than a mild recession could be lurking.